Treasurys end day, week lower

Biggest weekly rise since March for 10-year yield

By

RachelKoning

CHICAGO (MarketWatch) - Treasurys fell Friday and finished with the biggest weekly rise in the benchmark 10-year yield in nearly seven months as the bond market looks for a Federal Reserve interest-rate increase next Tuesday and probably at each of the central bank's next two meetings.

Early price gains seen on back of mostly mild readings on current inflation faded by afternoon. Yield and price move inversely. Investors demand higher yields to partly offset inflation risks, but this also raisies borrowing costs.

With prospects for rising interest rates and yet, some uncertainty over whether a "measured" pace of rate increases at the Fed will be enough to keep inflation at bay, the benchmark 10-year note finished 4/32 lower at 97 15/32. That trims $1.25 per each $1,000 in securities at face value.

The note was yielding
TNX, +3.23%
4.57% compared to 4.55% at Thursday's close.

The note's yield this week traded to 4.6% this week for the first time in over six months, but was checked before reaching the year's high of 4.68% hit March 23. The yield influences mortgage and corporate borrowing rates.

"It was a week in the U.S. bond markets when Treasurys led the way down, especially the 10-year," said Lipper's senior research analyst for bonds Andrew Clark.

"With the announcement on Monday of Ben Bernanke as President Bush's choice to replace Alan Greenspan as chairman of the Fed, the Treasury markets sold off on fears that Bernanke would not be as vigilant on prices and would be more friendly to inflation targeting than outgoing Chairman Greenspan," he said.

The bond market never really regained traction this week.

The 10-year note yield gained 0.16 percentage points, its biggest weekly climb since the second week in March, a week that produced a jump in energy prices that incited inflation worries.

Merrill Lynch & Co. data show that bond market returns overall so far this year are at a 1.25%, the leanest returns in some six years.

The bond market showed little reaction to news on Friday that a top aide to Vice President Dick Cheney, Lewis "Scooter" Libby, has been indicted on obstruction and perjury charges for his role in the leak of a CIA agent's identity. He promptly resigned from the administration. See full story.

Short-term notes fell after the news, as the stock market held its gains in relief that more top administration officials were not charged. Short-term notes are sometimes sought as a "safe haven" investment away from losses in riskier investments such as stocks.

Some analysts speculated that the investigation, which is still ongoing, could distract a White House trying to advance a second-term agenda already up against lowered approval ratings and high energy prices.

Early, data-driven gains for Treasurys had been sapped by midday. The bond market turned more defensive ahead of next week's busy calendar, which in addition to the Fed interest-rate meeting, includes the jobs report, quarterly Treasury auction announcements and congressional testimony from Fed chief Alan Greenspan.

Treasurys initially firmed in response to mixed U.S. economic data - stronger growth, but milder inflation - that most said allows the Federal Reserve to stick with modest interest-rate changes and not adopt a more aggressive response.

The bond market is already prepared for a quarter-point rate hike next week and likely again in December and January.

The U.S. economy expanded at a faster-than-expected 3.8% annual rate in the third quarter, a Commerce Department report showed.

The economy has now expanded at a 3% or faster clip for 10 consecutive quarters. Faster growth rates may invite higher inflation levels that strip bond investments of their value.

But so far, inflation has been limited from expanding into the broader economy, according to most government data.

The GDP report includes a price gauge favored by Federal Reserve Chairman Alan Greenspan -- personal consumption expenditures deflator, excluding food and energy. It increased at a 1.3% annual rate compared with 1.7% in the second quarter.

It was the mildest rate for a core price increase since the second quarter of 2003. See Economic Report.

"We should not expect growth to remain this strong over the next few quarters, but at least we really should not have any worries about a recession," said Joel Naroff, president of consulting firm Naroff Economic Advisors.

"What worries me is the disconnect between the forward looking core deflator and the cost of living, which is what we all have to deal with. The markets think inflation is the core rate. It is not. The core simply is the best forecaster of future top line inflation. And right now, that is high and is creating real uncertainty for both households and businesses.

The bond market also got some friendly data in a report on labor costs.

In the past 12 months, overall employment costs have risen 3.1%, the smallest annual rise in six years, as companies continue to squeeze workers' pay. See Economic Report.

"Wage increases remained moderate on this measure and the absence of significant wage pressures is another factor that should keep the pace of rate hikes measured," said John Ryding, chief economist at Bear Stearns.

The bond market initially held its mild gains after the day's third report showed that U.S. consumer sentiment fell slightly in late October.

Consumer spending heading into the holiday season could become even more important in trying to guess when the Fed will stop raising rates. Consumer spending is two-thirds of GDP.

So far, soured sentiment hasn't translated into a steep selloff in buying.

According to media reports of proprietary research at the University of Michigan, its national consumer sentiment index dropped to 74.2 in October from 76.9 in September and 75.4 in early October.

It's the lowest reading since October 1992. Economists expected a bounce to 75.9 in the final October reading.

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